People are ethical or unethical, not compensation methods. Yet, there is a simple elegance about the flat-fee-for advice financial advisor. It's totally transparent. There is never any question about how you're being paid or whether there is a potential conflict of interest.
It's very easy for the client to understand. It makes the "product" the advice rather than the product being a financial plan, investments, insurance, annuities, tax returns and/or legal documents. Whether you like it or not, there can be a perception that if you get paid by a product or service provider you may be influenced by higher compensation or better perks.
Consumers and the regulators naturally ask questions like, "Was that the best product for the client or was that product recommended because it paid a higher commission or a bonus or qualified the seller for the trip to Hawaii?"
It's possible for a client or prospective clients' perception of your trustworthiness to be different than your actual trustworthiness. And this perception could be influenced by how you choose to be paid.
This article explores three things:
The trends that I see that are leading to a flat fee for advice financial services world. I believe this is inevitable and may happen rapidly and soon.
Why it matters to you.
How you can capitalize on this opportunity. (You can hear more from Bill Bachrach on flat fees during an upcoming Webinar.)
Consider the term "new normal" as a way to understand the trends that will make the flat-fee-for-advice model ubiquitous, possibly very rapidly and much sooner than you might think possible. I believe this term "new normal" has become popular because of how rapidly something can change, leaving what used to be normal forever in the dust. Here are a few examples:
The first cell phones were called "car phones" because they permanently mounted in your car. They cost $2,000 plus 20 cents to 40 cents a minute and they only made and received phone calls. We were THRILLED to have them. Car companies built them physically into their cars, mounting them inside the console or the dashboard. They were ubiquitous ... until they weren't. How much would you pay today for a cell phone permanently mounted in your car? Nothing. You would not buy the product at any price. The new normal is the "smart phone." And that change happened fast.
A good example of an old-normal to new normal game-changer in our industry is Charles Schwab. Before Charles Schwab, the old normal was to pay hundreds or thousands of dollars for a single stock trade. In the old world, a stock commission was based on two variables: 1) the number of shares; 2) the price per share. Schwab figured out that stock trades are a fixed cost business and just because you have more shares that are worth more money you shouldn't have to pay more to sell them.
Ditto on the buy side. He entered the industry by telling the world that he'll handle all the stock trades you want at the incredible bargain price of $150 per trade. And that became the new normal ... until it wasn't. How many stock trades would you do today for $150? The new normal is seven bucks. The irony is that today Schwab looks a lot like the kind of firm they criticized when they began. They basically entered the industry saying, "You are being overcharged by your stockbroker. Don't pay hundreds or thousands of dollars to a stockbroker or so-called financial advisor. Do it yourself and pay less." Now they have branch offices, financial advisors and a robust support system for independent financial advisors. First they created a new normal in the industry and now their own new normal is very different from their original value proposition.
Needless to say, the stockbrokers in that soon-to-be-old world (mid-1980s) were not happy with Charles Schwab. Many believed they would be put out of business and, indeed, some quit. To some extent, I believe Schwab's killing of the stockbroker spurred the mutual fund explosion.
Many stockbrokers shifted to being mutual fund salespeople. And many mutual funds paid 8% up-front commission ... until they didn't. The new normal became 4%. And then the asset-gathering movement began. "Annuitize your book!" the leaders of the financial services industry exclaimed.
Which meant, wrap an ongoing percentage fee around money management services such as mutual funds or separately managed accounts. That percentage continued to be commoditized and landed, more or less, at 1%. Many advisors could not imagine "living in a 1% world" ... until they could and the new normal became about 1% of AUM to the advisor.
The takeaway here is that you shouldn't get used to things being a particular way, because they can change rapidly. The rate at which the current normal gets replaced by the new normal is accelerating across all industries, including ours.
Here are some examples supporting my belief that the new normal will be a flat fee for advice and could be mainstream soon.
RIA-only firms growing rapidly.
Broker-dealers going from accommodating advisors who want to be fee-only to actually supporting them.
Fee broker-dealers. There are now B-Ds that charge a fee for their support rather than a percentage override of your production and receive no compensation from the product providers on your sales.
The proliferation of services like "RIA in a Box" to help advisors make this transition.
The proliferation of no-fee/no-commission annuities and insurance products with all the features of fully loaded products. While these have long been available on a smaller scale and with fewer features, they are going mainstream. It seems the insurance and annuity companies are recognizing the market potential of the RIA and flat-fee-for-advice model. (See Gail Liberman's article in the July 2011 issue of this magazine.)
The continuing advisor mindset shift from gathering assets and being investment focused to giving advice about achieving goals and getting your entire financial house in order.
An insurance-company-owned B-D recently hired me to help them convince their most successful advisors/agents that they should convert their business to flat-fee-for-advice and to teach them how to do it. Read that again: an INSURANCE-company-owned B-D.
Australia and other countries whose governments are mandating a fee-for-advice model. Instead of having government agencies police the potential conflicts of interest and inspect for full disclosure, they are "solving the problem" by simply eliminating conflicts. The solution? Progressively eliminating commission and fee compensation based on products and requiring that advisors be paid directly by their clients for advice. Their rationale is that the client and the advisor should work out how valuable their advice is and set the price rather than that being determined by the product/service providers, thereby forcing the client to figure how much their advisor is being paid through some combination of advisor disclosures and reading complicated legal documents like prospectuses. In other words, "Tell me what you'll do for me and how much you charge, and if I agree I'll pay you for it." One of their goals is to eliminate any financial person ever again saying something like, "You really don't pay me anything; the product provider we choose pays me."
You can read more about this at http://futureofadvice.treasury.gov.au. Similar things are happening, or have happened, in the U.K. and other countries. I am not predicting that our government will intervene in the same way. I believe that market forces will drive this change here. Just as 1% of assets have become the new normal for compensation, I believe it will be replaced by the next new normal of a flat fee for advice.
The word is beginning to spread that financial services could be a fixed-cost business, not basis points. Similar to Schwab figuring out that people with bigger stock trades don't have to pay more to sell or buy, money managers are acknowledging that there is little, if any, difference in the work involved to move $10 million or $5 million or $1 million into the markets. Therefore, they are setting themselves up to be paid a fixed, flat fee to manage the money instead of basis points on the assets. Some insurance experts are doing the same thing.
The recent economic downturn and market decline caused many advisors to realize that it doesn't make sense for the fee and their income to fluctuate based on market or economic events. Clients need, and are willing to pay for, their advice in all economic cycles.
Wealthier clients are beginning to grumble about feeling gouged by an asset fee that requires them to pay more for the same service just because they have more money. "If it doesn't cost any more to manage my $5 million portfolio than it does to manage a $1 million portfolio, why am I paying so much more?"
It's a good point. Your challenge, if you are a percentage-of-assets fee-based advisor, is that if another advisor comes along and tells your client about a flat-fee-for-advice model that provides the same or better value at the "new normal" price before you do, it could create a trust breach between you and your client. Wealthy people don't mind paying their fair share, but it irritates them when they discover that they are paying more to subsidize the people who pay less. Are your clients with more money subsidizing your business so you can afford to serve clients who pay you less?
Here's a script for talking to your clients if you choose to transition to a flat fee for advice: "Based on how the financial services business is evolving, we believe that you are better served by paying a flat fee for our advice and service rather than a percentage of your assets. We do so much more for you than just investment management and we believe the way you are paying us no longer reflects the value we provide. So today we are going to review every element of the service we provide for you and propose a flat fee for our service instead of variable percentage of assets."
Explain what you do, the value to them, how much you will charge for this value going forward, and answer their questions. For some clients, the fee may go down and for others the fee may go up. What's important is the fee for everyone is right-sized and the value the client receives exceeds the fee.
How do you set your fee?
Do the money math and decide how much total business revenue you need in order to cover your business expenses, pay your taxes and have plenty of personal income to pay for your present lifestyle and fund your future goals.
Do the time math: How many clients do you want to have and how many do you actually have time to serve given your desired number of work days/year and work hours per day. Hint: You can only deliver truly comprehensive financial services for 100 or fewer clients.
Divide your required business revenue by the number of clients and that equals your minimum fee. Then consider the value-based method for setting your fee. In other words, what is the value of this service for the people to whom it's being provided?
You may only need a $10,000/client, but the value may actually be $20,000 for your ideal or target client. In that case, I recommend that you set your fee at $20,000 and reduce your target number of clients. You make all the money you need to run your business and make your life work and have more time (which is much more valuable than money) to live an even better life.
Why does this matter to you? Because when you proactively transition to a fee for advice, you will create greater client loyalty with your existing clients and easily "steal" clients from other advisors and institutions who are slow to adapt.
The HUGE opportunity for the flat-fee-for-advice advisor is to present a better value proposition at a lower fee. The result will be some clients transitioning all of their financial services business from their current relationship(s) to you. Simply put, you can deliver a better value proposition (truly comprehensive financial services) very effectively for, let's say, $20,000/year.
Anybody paying more than that as a percentage of assets and basically getting just asset management and a few other services is the perfect candidate to hear the message of how much more value they could be getting from you for the same or lower fee. You were looking for a way to get higher net worth clients in this economy? Now you have it, but this window of opportunity may not be open for long.
For 23 years, Bill and his team have been helping advisors attain top 1% success as measured by value delivered to the client, financial success and quality of life. To learn more go to www.billbachrach.com or call 800-347-3707 to schedule a Success Road Map® consultation.